The PATH Act Brings Federal Income Tax Changes
The Protecting Americans from Tax Hikes Act of 2015, also known as the PATH Act, was enacted by Congress at the end of 2015. Below are the highlights from that legislation.
Tax extenders are popular but traditionally temporary tax breaks. There are more than 50 extenders, which in the past have routinely been extended for one or two years usually late in the calendar year, but were effective as of the beginning of that calendar year. That process created a great deal of uncertainty.
The PATH Act extends permanently some, but not all, of the extenders. Those permanent extenders include:
- Reduced earnings threshold for additional child tax credit, allowing a larger refundable portion of this credit
- Earned income credit modifications, making permanent a phase out amount set to expire in 2018
- Teachers’ classroom expense deduction, continuing the deduction for classroom expenses, indexing the limit for inflation and starting in 2016 adding professional development expenses for curriculum in which the teacher is the instructor
- State and local sales tax deduction, allowing residents of states without an income tax to deduct their sales taxes as an itemized deduction
- Transit benefits parity, increasing the exclusion for transit passes and van pooling to the amount excluded for qualified parking
- Special rule for qualified conservation contributions of capital gain real property to be considered a 50 percent charity
- Tax-free distributions from IRAs for charitable purposes for individuals age 70 1/2 and older is still capped at $100,000 per year. Additional amounts can be charitable contributions as itemized deductions but must be included in gross income
- Enhanced Code Sec. 179 expensing, permanently sets the $500,000 limit and the $2 million investment limitations, indexed for inflation beginning in 2016. Retains the "qualified real property" special rules for Code Sec. 179 expensing and removes the $250,000 cap on this category starting in 2016
- Research tax credit, allowing qualified small businesses to claim the credit against alternative minimum tax liability and qualified startups to claim part of the credit against social security tax liability
- Tax treatment of certain payments to controlling exempt organizations, removing an expiration date from a provision that limits the amount of income an exempt organization must report for an expense item paid by a taxable subsidiary
- Basis adjustment to stock of S corporations making charitable contributions of property, making permanent the reduction in the basis of each shareholder being limited to the adjusted basis of the property while it was owned by the S corporation
- Employer wage credit for activated military reservists
- 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements, in lieu of the longer recovery periods that apply to comparable properties
- Treatment of certain dividends of regulated investment companies, removing such dividends from the otherwise applicable 30 percent tax when paid to certain foreign investors
- Exclusion of 100 percent of gain on certain small business stock, making permanent the exclusion from gross income when held for more than 5 years
- Reduction in S corp recognition period for built-in gains tax to 5 years, starting in 2015, thereby reducing corporation level tax exposure
- Subpart F exception for active financing income, making permanent the controlled foreign corporation provisions exception from immediate taxation, even without distribution, for income derived from an active banking, financing or similar business
- Temporary minimum low-income housing tax credit rate of 9 percent for non-federally subsidized buildings is made permanent
- Military housing allowance exclusion for determining whether a tenant in certain counties is low-income for purposes of financing provided by exempt facility bonds
- RIC qualified investment entity treatment under FIRPTA, which operates as a possible exception to status as a U.S. real property holding corporation and the attendant withholding of income tax upon disposition in certain instances
Charitable deduction for contributions of food inventory the enhanced deduction for such contributions is made permanent and the starting in 2016, the percentage limits are increased for individuals and C corporations and the fair value and basis determinations are made easier
Extenders extended through 2019: The PATH Act also extends, and in some cases modifies, through 2019, the New Markets Tax Credit, Work Opportunity Tax Credit, bonus depreciation, and look-through treatment of payments between related controlled foreign corporations. The most significant of these is for bonus depreciation as it is extended on a phased down basis through 2019: 50 percent for 2015-17; 40 percent in 2018 and 30 percent in 2019.
Starting in 2016, bonus depreciation is expanded in that the old term of "qualified leasehold improvement property" for which bonus depreciation is available is expanded to "qualified improvement property" a broader term in that the property does not need to be placed in service pursuant to the terms of a lease. Also starting in 2016, certain trees, vines and plants qualify for bonus depreciation.
Extenders extended through 2016: Additionally, the PATH Act extends, and in some cases modifies, through 2016, the:
- Exclusion from gross income of discharges of acquisition indebtedness on principal residences. The discharge must occur before January 1, 2017 or be subject to an arrangement entered into in writing before that date
- Mortgage insurance premiums treated as qualified residence interest is continued for individuals, subject to a phase out for adjusted gross income exceeding $100,000
- Deduction for qualified tuition and related expenses at educational institutions, subject to a phase out, as under current law; the IRS is likely to impose a 1098-T filing requirement
- Indian employment tax credit available to employers of Indian tribe members in certain instances
- Qualified zone academy bonds, issued by state and local governments for school costs, and generate tax credits rather than pay interest that is exempt from federal income tax
- 7-year recovery period for motorsports entertainment complexes, i.e., race track facilities and related land improvements
- Accelerated depreciation for business property on an Indian reservation, i.e., shorter recovery periods
- Election to expense mine safety equipment of mining companies
- Special expensing rules for certain film and television productions, adding theatrical productions starting in 2016
- Code Sec. 199 deduction for Puerto Rico, which deems Puerto Rico part of the United States for purposes of the deduction for domestic production activities
- Empowerment zone tax initiatives including tax exempt bond financing, tax credits for employing resident workers, enhanced Section 179 expending and tax free rollovers
Increase in limit on cover over of rum excise taxes to Puerto Rico and the Virgin Islands, which results in paying back the taxes paid on rum brought to the U.S. from these possessions
Included in the PATH Act are extensions of extenders intended to encourage energy conservation and the development of non-fossil fuel energy sources. These incentives include the Code Sec. 25C credit for nonbusiness energy property (e.g., insulation, efficient windows and HVAC systems still subject to $500 lifetime credit), credit for alternative fuel vehicle refueling property, second generation biofuel producer credit, biodiesel and renewable diesel incentives, credit for the production of Indian coal facilities, credit for energy-efficient new homes, special allowance for second generation biofuel plant property, energy efficient commercial buildings deduction, special rule for sales or dispositions to implement FERC or state electric restructuring policy for qualified electric utilities, excise tax credits and payment provisions relating to alternative fuel, and credit for fuel cell vehicles. The fiscal year 2016 omnibus provides for an extension of the wind production tax credit (subject to phase-down) and certain incentives for solar power (also subject to phase-down). Some of these are extended through 2016 and some are longer.
Code Sec. 529 plans continue to be popular vehicles to save for higher education. The PATH Act makes permanent that qualified higher education expenses for 529 plans include the purchase of computers, software and internet access. The PATH Act also revises the rules for aggregation and refunds. The PATH Act also makes some taxpayer-friendly changes to ABLE accounts, which are similar to 529 plan accounts for disabled individuals and disability expenses. No longer is the beneficiary required to reside in the state in which the account is created.
AFFORDABLE CARE ACT
When Congress passed the Affordable Care Act (ACA) in 2010, lawmakers included a number of revenue raisers to help offset the cost of health care reform. The ACA imposes an excise tax on qualified medical devices. The ACA also imposes an excise tax on high-cost employer-sponsored health insurance. Additionally, the ACA imposes a fee on health insurance providers. These three provisions in the ACA are modified by the PATH Act and the fiscal year 2016 omnibus.
The PATH Act imposes a two-year moratorium (for sales in 2016 and 2017) on the ACA’s excise tax on qualified medical devices. The fiscal year 2016 omnibus provides for a two-year delay of the excise tax on high-cost employer-sponsored health coverage (also known as “Cadillac” plans). Under the fiscal year 2016 omnibus, the excise tax on high-cost plans will first be effective in 2020 rather than in 2018, as originally scheduled by the ACA. The fiscal year 2016 omnibus also makes the excise tax on high-cost plans deductible as a business expense to the employer/payor.
Included in the PATH Act are clarifications for church plans and certain governmental plans. The PATH Act also permits rollovers from qualified plans into SIMPLE IRAs. Starting in 2016, the 10 percent early distribution tax for public safety employees separating from service after age 50 also applies to federal law enforcement officers receiving retirement plan distributions.
IRS BUDGET AND OPERATIONS
Many taxpayers experienced problems contacting the IRS during the 2016 filing season. The IRS could not answer all of the calls it received from taxpayers with questions. In fact, customer service levels fell to new lows. According to the IRS, cuts to its budget in recent years contributed to its poor customer service. The fiscal year 2016 omnibus allocates an additional $290 million above fiscal year 2015 levels to the IRS to improve customer service. Congress also directed the IRS to use the additional funds to improve cybersecurity and continue to uncover and prevent tax-related identity theft and refund fraud.
Lawmakers also added the IRS's Taxpayer Bill of Rights to the Internal Revenue Code (by charging the IRS Commissioner to ensure employees are familiar with such rights), prohibited the use of personal email for official business, and provided for termination of employment for taking official actions for political purposes, among other changes for agency employees.
The year-end legislation also includes a number of provisions affecting how the IRS reviews and grants applications for social welfare organizations, allowing for a streamlined application process. In an attempt to halt an IRS theory of imposing a gift tax on contributions to certain tax exempt organizations, the PATH Act states that contributions to social welfare organizations, agricultural or labor organizations or to business leagues that are tax exempt cannot be subject to the gift tax if made for the use of those organizations.
Finally, tax exempt organizations of all types are provided an administrative appeal for adverse determinations of tax exempt status and an expanded right to pursue a declaratory judgment regarding such status.
Congress also modified the U.S. Tax Court's jurisdiction, allowing more interest abatement cases, modifying where certain decisions can be reviewed and allowing the suspension of the limitations period for filing cases in the tax court for innocent spouses and collection actions. The Federal Rules of Evidence apply in tax court cases. The PATH Act provides for certain administrative changes to the tax court’s operations, impacting judicial conduct and judicial conferences.
The PATH Act makes a number of changes to real estate investment trusts (REITs). These include restrictions on tax-free spinoffs, repeal of a preferential dividend rule for publicly offered REITs, treatment of certain services provided by taxable REIT subsidiaries and more.
Included in the year-end legislation are several measures treated as revenue raisers. These provisions include updated standards for the energy efficient commercial buildings deduction, excise tax equivalency for liquefied petroleum gas and liquefied natural gas, exclusion from gross income of certain clean coal power grants, clarification of valuation rule for early termination of certain charitable remainder unitrusts, prevention of transfer of certain losses from tax indifferent parties and treatment of certain persons as employers with respect to motion picture projects.
This summary does not cover all of the PATH Act changes and it may exclude some that apply to your situation. Please contact Charles Jensen, or any of Stinson Leonard Street tax attorney to discuss your specific situation.